- Captive viability often scrutinised more during soft market cycles
- Important multi-member captives prepare for possible company exits
- Soft market can provide new opportunities for captives
Despite indications of a softening global insurance market, captives are expected to continue to be a popular tool for those companies looking for substitutes for the traditional insurance market.
Captives are often considered as an alternative solution to negating rising costs in the commercial market.
They offer more to an organisation’s risk financing strategy beyond pricing and capacity, and it is important they are seen as long-term tools and not solely reactive to market trends.
For example, during a softer market, captives have better access to reinsurance and are also in a better position to negotiate more positive terms.
While some lines such as property remain particularly problematic in the United States and Asia, and continue to prompt new captive formations, other markets such as cyber which had previously seen triple digit rate increases, are now beginning to soften somewhat.
According to Aon’s Q3 2024 Insurance Market Overview, abundant capacity has led to improved pricing and terms across wider swaths of the market.
“For example, well-performing property risks are increasingly oversubscribed and modest price reductions are available, while many clients are choosing to take advantage of favourable cyber market pricing by purchasing additional limit,” the report said.
Competition for these and other preferred risk types is expected to accelerate in a growth focused Q4 market.
Impact of a soft market
Yann Krattiger, head of alternative risk transfer EMEA at Swiss Re Corporate Solutions, said he has experienced multiple market cycles, but he has not observed a strong correlation between shifts in hard and soft markets and captive appetite.
“The hard market has forced corporations to use their captives as a buffer to manage their budget constraints between insurance market costs and their overall insurance spending,” he told Captive Intelligence.
“This has raised awareness and led to some growth in lines under pressure.”
Krattiger said that it is not just about price, but also coverage, terms and conditions.
“When clients cannot find the necessary coverage, they turn to their captives,” he added.
“What all our clients tell us is that they see substantial psychological obstacles to shift large portions of risk to a captive initially without a retrocession solution.”
Krattiger said that in the commercial market approximately 60 to 70% of premiums go toward paying claims, while in a captive, that figure is about 80 to 90%.
“We need to differentiate between layers; captives are most effective when retaining attritional losses or frequency losses,” he said.
“Captives may take advantage of some price arbitrage, particularly in excess capacity.
“For the bulk of primary risks that captives typically cover, I believe the trend will remain steady over the long term.”
Chris Sutton, partner in speciality broking at McGill & Partners, said the intermediary does not typically see clients backtracking on captive utilisation during a softer market, “although there are always exceptions”.
“Once companies have invested the time and effort to establish a captive — such as capitalising it, building the necessary operational infrastructure and appointing directors — they tend to appreciate the benefits,” he said.
Vittorio Pozzo, director for Europe & Great Britain in the captive advisory team at WTW, said there will be some impact from a softening market, as captives in Europe are typically attracted to hard markets or those that are challenging for certain classes.
“However, given the recognised validity and value brought by captives so far across Europe, I believe that traction for captives will continue as they are now indeed recognised as a strategic tool by the European risk and insurance management community, as also testified by the most recent conversations during the 2024 FERMA forum in Madrid,” he said.
Amy Evans, executive vice president at Intercare Holdings, Inc, said that in soft markets, we usually see captives being parked or slowed down a bit or not being used to their full capacity.
“People are using the additional resources that are available in the soft market,” she said.
“But we can occasionally see new captives being formed if they see a line of business in the commercial market that they think they can do better.”
Benefits of a soft market
Although historically captives have often been established as a reaction to a hard market, a soft market offers its own benefits to captive owners.
Simon Camilleri, executive director at Artex Risk Solutions, said that retaining captives in a soft market allows companies to take advantage of improved terms and conditions that may not be available otherwise.
“In a soft market, captives have the opportunity to renegotiate terms with reinsurers and secure better deals,” he said.
“Ultimately, a captive serves as a profit centre for a company.
“When the market is soft, reinsurance becomes cheaper, which can increase the profitability of the captive, benefiting the parent company.”
During soft markets, opportunities can also extend beyond simply better premium and capacity terms.
“New products, coverages, and evolving risks emerge, making it essential to prepare your captive for these changes,” Evans said.
“As a captive owner, strategic planning is important, and one key factor to assess is whether the captive can address new and emerging risks.”
Peter Carter, head of captive and insurance management and head of the climate practice at WTW, said there’s an argument for potentially taking some of the savings from the commercial market and considering whether to write more risk in the captive where commercial pricing is not as attractive.
“This could include risks like political violence or cyber,” he told Captive Intelligence.
“It’s an opportunity to build reserves in the captive, as the market will not stay soft forever. When the market turns, having a robust contingency and resilience will be crucial.
“The captive still has an important role to play, especially as we discuss new and emerging risks, such as those arising from climate change.”
Evans said that if the captive cannot address these new risks, then companies need to determine how to respond, whether to incorporate these risks into the captive or partner with commercial carriers for suitable solutions.
“Ultimately, it is not just about premiums, and it is about leveraging resources, expanding coverage options, and ensuring your captive remains adaptable to shifting market dynamics,” she said.
Rob Geraghty, international consulting and sales leader at Marsh Captive Solutions, highlighted that companies establish captives for qualitative reasons as well as quantitative ones.
“While discussions about challenging markets – hard or soft – often focus on numbers, it’s important to consider the qualitative benefits,” he told Captive Intelligence.
“These include direct access to reinsurance, terrorism pools, enhanced control over risk management, claim reserving, pre-funding, and reducing volatility. Captives are established for a variety of reasons beyond just price and cost.
“It’s a long-term strategy, and the market can change frequently.”
Changes during a soft market
David Vigier, chief commercial officer for France at HDI Global, said that regardless of the market cycle, having an ambitious captive and self-financing strategy is a strong indicator of the maturity of risk managers and corporations.
“Despite ongoing debates about market direction, we are witnessing consistent and increasing use of captives,” he told Captive Intelligence.
“This trend is a strong sign that risk managers are taking their roles and responsibilities very seriously.”
Stephen Cross, group COO & head of innovation & strategy at broker McGill & Partners, said that seasoned risk managers understand that prices fluctuate over time.
If they have a vehicle they’ve committed to over a longer period, they’re not just committing to their own risk — they are also likely to have a solid approach to risk management and mitigation because it involves their own money,” he said.
“Once corporates get accustomed to using a captive, it becomes difficult to revert to accepting more traditional options. While they might find cheaper alternatives, they risk losing control,” he added.
Oliver Davies, chief distribution officer at HDI Global for UK and Ireland, said setting up a captive should be for strategic, long-term objectives, irrespective of the market cycle.
“From that perspective, as a risk manager, you will navigate the market cycle to decide what risks to retain and what to pass off to the market, based on the pricing structures,” he said.
“It’s important to keep this in mind, as the goal is to protect the Group rather than worry about the wider implications of the market.”
Pozzo said he expects risk managers, CFOs, and insurance managers to carefully scrutinise the value of captives during a softer market and consider how to effectively set up and use the vehicle during this period.
“With the market softening, organisations clearly need to be confident that the value will be realised to justify the captive,” he said.
Evans said that it’s important that multi-member captives are prepared for the possibility of members leaving during a soft market.
“In such cases, having a well-defined exit strategy is essential,” she said. “This includes establishing robust contracts that outline the process for departure, assessing whether the remaining members can sustain the captive and determining the next steps if they cannot.”
Evans said it is also key for group captives and mutuals to tighten policies for departing members.
“They will still incur losses, so they will need to decide whether they will remain in the captive or if they will sell them in a Loss Portfolio Transfer (LPT),” she said.
“Additionally, consider whether you want them to retain consent to settle claims. If they have this consent, it could prolong the settlement process.”
Geraghty said that regardless of the market cycle, companies should assess their captive strategy each year and conduct a comprehensive strategic review every couple of years.
“It’s important to evaluate their objectives for the captive, which may have changed since it was established – whether that was 20 years ago, 10 years ago, or even just a few years ago,” he said.
“If we were to start with a blank sheet of paper today, what would a captive’s objectives be? It’s unlikely that cost savings would be the only reason; there are many other factors to consider.”